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“Bubble Watch” looks at trends that may indicate upcoming economic and / or real estate market turmoil. This time, a more philosophical analysis.
Bad news: California home prices seem to be on the rise.
The good news is that stocks don’t have to collapse painfully to correct the overvaluation.
Californians were left with understandable scars after the Great Recession destroyed psyches, careers, checkbooks and net worth. But that doesn’t mean every time homebuyers go crazy – a well-documented California habit – sharp and rapid price drops have to follow.
The surprisingly high house prices of last year in a tattered pandemic economy were baffling. It was a push mainly driven by historically low mortgage rates that have helped balloon house hunters want larger living spaces due to the overhaul of coronavirus lifestyles.
“Bubble” means that the price of an asset has exceeded its underlying value. No one has made it clear to me how housing will remain unscathed after the virus is destroyed and concessional funding wears off – although the Federal Reserve is giving a lot of warning, because it is promising.
Please note that a mere 1 percentage point increase in mortgage rates from current historic lows of less than 3% would reduce the purchasing power of a typical home hunter by about 12%.
So, I thought a history lesson was in order. I filled my trusty spreadsheet with California home price statistics from 1975, using a slow moving Federal Housing Finance Agency index. What I discovered were three separate “fixes” – defined by me as long periods between records for this index.
Yes, “it’s different this time” may be true. Each of these painful times has its own plot – from the backstory to the duration to the end.
1980s: quick fix
A battle against inflation resulted in a slight price correction over two years.
Home prices in California had jumped at a rate of 16% per year for seven years to reach record highs in the fall of 1981. It was an eventful time. Global instability and oil shortages created by an Arab embargo on US imports help bring inflation down to 9% that year, making those housing gains, not to mention paychecks, worth a lot less.
Then the Federal Reserve took tough action to temper inflation, intentionally cooling the economy. Yes, it seems central bankers often play a role in real estate. Interest rates have skyrocketed and mortgages have hit rock bottom highs above 18%.
But during this correction, prices only fell 11% to the low of the cycle – and would hit a new high in the fall of 1983 … as rates fell to, sip, 13%!
1990s: Long malaise
A bad economy translated into a housing malaise that lasted for much of the decade.
When the Fed stopped capturing the ’80s economy, business and housing in California exploded – although mortgage lending was never much lower than 9%. The housing-friendly savings and loan industry has actively lent in a last ditch attempt to save itself. Prices appreciated at an annual rate of 10% for 7 years to reach a record high in the summer of 1990.
Then California struggled to shake off a small national recession. S&L are gone and the end of the Cold War decimated the state’s aerospace industries. Mortgage rates have fallen below 7%.
But the housing fix of the 1990s is often overlooked due to its unusual pain.
A slow, winding economy meant that California’s next housing record wouldn’t be seen until fall 1998 – yes, more than eight years between peaks. But during this prolonged sluggishness, the price index fell only 13% to its low.
2000s: Big burst
A painful dip after a wave of real estate madness meant 12 years between peaks.
You would have expected the weakness of the 90s to turn into a significant rebound. There was a pent-up demand for housing. Additionally, California’s business climate has been overheated by the new dot-com economy. Prices have increased at a rate of 14% per year for eight years.
Real estate momentum seemed unstoppable as prices ignored a temporary collapse in tech industries, the 9/11 terrorist attacks and a mild national recession. How? ‘Or’ What? Aggressive lenders and willing borrowers were doing really dumb things – like buying homes that few people could afford.
Correcting these horrific business practices, poor regulation, and individual mistakes burst the bubble in the Great Global Recession. Housing in California collapsed in a fall that slashed the price index by 41% from its summer 2006 high.
It would take 12 long years – and mortgage rates below 5% – to erase those losses and hit a new high in the summer of 2018. And since then, the housing market has generated eight more high prices as the Fed has risen further. housing with rates below 3%.
At the end of the line
History tells you that the housing pain of the Great Recession was horrific – and quite possibly, not much of a parallel to the era of the pandemic. However, this does not mean that the overheated housing markets of 2021 will not face notable challenges.
Perhaps the terms of buying a home today are more like the early 1980s, when the Fed was trying to solve a larger economic challenge and the business climate reacted favorably to it. The correction in house prices at this time was swift and modest.
And don’t ignore the 1990s as a possible benchmark for a pandemic. The continued economic weakness of this decade has created a long funk for the California real estate markets.
Is what equates to eight years of zero home price appreciation a “crash” or a “correction”?
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